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Earnings effects of changes in useful lives and salvage values

Assume that Major Motors Corporation, a large automobile manufacturer, reported in a recent annual report to shareholders that buildings had an original cost of $4,694,000,000.

1. Major Motors uses the straight line depreciaiton method to depreciate the buildings over a useful life of 34 years.
2. Assume that the ratio of end-of-year accumulated depreciation on the buildings to their depreciable cost is 35.3%. This implies that the buildings, on average, are about 12 years old. Assume that Major Motors depreciates them to a salvage value of 5% of their original cost.
3. Assume that Major Motors' management is considering both extending the original useful lives of the buildings to 40 years from 34 years and increasing the salvage value to 10% of the buildings' original cost.
4. Assume a tax rate of 34%

1. What is the book value of the buildings at the end of the current year(that is, before adjusting for any change in useful lives or salvage values)?

2. What would be the dollar amount and direction of the effect on Major Motors' net income if the proposed changes to the useful lives and salvage values were implemented at the start of the next fiscal year?

Solution Summary

The earning effects of changes in useful lives and salvage values are discussed.